Controlling Income and Accelerating Wealth Creation with a Cash Balance Plan

Wealth creation is often a battle of attrition with time being your greatest weapon. The reality of chasing wisdom to achieve your desired financial outcome creates unique challenges that require unique solutions to fast-track wealth generation. While it is true that the best time to plant a tree is 20 years ago, the second-best time is today. And wouldn’t it be helpful if that tree provided tax benefits and an accelerated funding mechanism? This is where a cash balance pension plan comes into play.

An approach that packs a big punch.

A cash balance pension plan is a qualified pension plan that can work in conjunction with a 401(k) plan. It is a type of defined benefit plan, more commonly known as a pension plan. The IRS provides for two types of qualified retirement savings vehicles to businesses: the commonly-utilized defined contribution plan and the less-common defined benefit plan. While a defined contribution plan, 401(k), is a product of the funds deposited past and present, a defined benefit plan is valued based on a future promise of benefits earned.

What are the advantages?

Cash balance plans can be very attractive to successful small business owners, particularly independent medical practices which have staff demographics that favor the plan’s design and testing requirements. In Ascensus’s most recent National Cash Balance Research Report, they found that 2020, cash balance plans have grown at twice the rate of 401(k) plans. Currently, 37.7% of all cash balance plans are attributed to healthcare firms. And 61% of plans have 10 participants or less.

Wealth acceleration.

Contributions to a cash balance plan can be significantly higher than the contribution limits in a 401(k) plan and are a factor of age. The maximum benefit accrual for an individual between 55 and 59 years old is $274,000. This benefit can be overfunded for a period of time, allowing an even greater deductible funding opportunity in some circumstances.

Tax mitigation.

As a qualified plan, contributions to a cash balance plan are deductible. A defined benefit plan is employer-funded, making contributions a deductible business expense. This tax savings allows for expanded funding ability, increasing an owner's financial growth opportunity.

Efficient allocation.

While cash balance contributions are subject to non-discrimination testing, the allocation of benefits is generally very favorable for medical practice owners. Cash balance plan benefits are a factor of age and income. Relative to other small businesses, medical practices comparatively hire a smaller, younger staff with a higher dispersion of wages. It is not uncommon to see 90% or more of the benefits accruing in a plan going to the owners if strategically designed.

Flexible contribution limits.

Cash balance plans are considered permanent plans by the IRS, and as such, there needs to be a commitment to funding the plan for multiple years. However, when a cash balance’s plan design and contributions are properly managed, there is a wide and growing range of funding options. For example, mature cash balance plans can provide minimum funding of zero dollars with a maximum deductible funding of several hundreds of thousands of dollars.

Income engineering opportunities.

When managing a cash balance plan to provide a wide range of funding options, the plan can then be used as part of an income engineering strategy. Contributions can be used to shift profit away from a current tax year, avoiding specific marginal brackets or certain tax phaseout thresholds, such as the qualified business income deduction (QBID).

Wealth Protection.

A cash balance plan enjoys Employee Retirement Income Security Act of 1974 (ERISA) legal protection. This federal law safeguards the retirement assets of employees and can secure funds from bankruptcy and creditors.

This strategy is a powerful tool for both practice and personal financial plans. The lifetime tax savings offered by a properly designed and administered plan can equate to millions of dollars in tax savings and wealth creation over the lifetime of an owner clinician. To maximize the benefits of a cash balance plan while minimizing the significant risks of a poorly designed plan, care should be taken in plan design with an understanding of not just current year funding goals but the long-term plan.

If you would like to explore how a cash balance plan may impact your bottom line, our team would love to help! Schedule a conversation with a Buckingham practice integration advisor today.

For informational and educational purposes only and should not be construed as a specific investment, accounting, legal, or tax advice. Certain information is based on third party data and may become outdated or otherwise superseded without notice. Third party information is deemed to be reliable, but its accuracy and completeness cannot be guaranteed. Neither the Securities and Exchange Commssion (SEC) nor any other federal or state agency have approved, determined the accuracy, or confirmed the adequacy of this information. R-24-7407